Procyclical Behavior of Institutional Investors During the Recent Financial Crisis: Causes, Impacts, and Challenges

Abstract

This paper (i) provides evidence on the procyclical investment behavior of major institutional investors during the global financial crisis; (ii) identifies the main factors that could account for such behavior; (iii) discusses the implications of procyclical behavior; and (iv) proposes a framework for sound investment practices for long-term investors. Such procyclical investment behavior is understandable and may be considered rational from an individual institution’s perspective. However, our main conclusion is that behaving in a manner consistent with longterm investing would lead to better long-term, risk-adjusted returns and, importantly, could lessen the potential adverse effects of the procyclical investment behavior of institutional investors on global financial stability.

Keywords: Investment, Private sector, Financial institutions, Financial instruments, Asset management, Financial crisis, long-term investments,institutional investors, procyclicality, financial stability, financial system, financial markets, bonds, hedge, financial assets, hedge fund, bond market, net present value, equity markets, financial statements, asset bubbles, bond funds, international capital, treasury bonds, hedge fund managers, financial sector, hedge funds, asset valuations, bond portfolio, corporate bond markets, hedging, financial systems, global stock markets, stock investment, sovereign bonds, financial instability, international financial markets, financial contracts, bond valuation,

JEL Classification: G01, G11, G15, G21, G23, G32, H12